When it Comes to Regulation, Should Size Matter?

In theory everyone agrees that smaller institutions don’t need to be subject to the same regulations as larger ones. In practice, it is often difficult to determine where to draw the line between big and small institutions and determine which regulations the small guys don’t need to comply with.

A recent speech by Federal Reserve Board member Daniel K. Tarullo is getting a lot of attention, at least among those of us who spend time analyzing banking regulations. The speech is important because he lays out a framework for policymakers and regulators to use in determining which regulations should be imposed on what institutions. Although his framework deals with mandate relief for community banks, the issues he raises are just as pertinent to credit unions.

Reviewing the issue of regulatory burden from the perspective of a former law school professor, he argues that, prior to the financial crisis, financial institutions irrespective of their size were basically all treated the same for regulatory purposes. In addition, the focus of regulators was narrowly tailored to commercial banks with the result that institutions such as Lehman Brothers were subject to less regulatory oversight than was a typical community bank.

Fast-forward to the present day and Dodd-Frank is the first major piece of banking legislation to recognize the need for regulating not only banks, but all institutions that have a systemic impact on the nation’s financial system. In addition, regulators shifted their focus from institutional regulation to financial risk writ large.

However, Tarullo feels that much more needs to be done to determine what regulations need to be imposed. He argues for a system where “the aims of prudential regulation for traditional banking organizations should vary according to the size, scope, and range of activities of the organizations. By specifying these aims with more precision, we can shape both a more effective regulatory system and a more efficient one.”

This standard has both plusses and minuses for the credit union system. Simply put, credit unions do not pose a systemic risk to the nation as a whole and needn’t be subject to regulations designed for larger institutions. For example, Tarullo would grant mandate relief to institutions with less than $50 billion in assets. So does this mean that credit unions should be subject to no regulations? Of course not, but it does mean that NCUA shouldn’t import models, such as the Basel framework, intended to regulate the conduct of much larger interconnected institutions and try to impose them on credit unions. If NCUA wants to talk about systemic risk as a justification for its regulations, then it has to show credit unions are interconnected in a way that the failure of one would bring down others.

What about the post Dodd-Frank consumer lending regime? Again, ask yourself what is the aim of the legislation? If its aim is to prevent perceived abuse of consumers then hold those institutions — be they banks or brokers — that committed the systemic abuse to a higher standard. Instead, the CFPB grants mandate relief only to institutions with $2 billion or less in assets that comply with certain conditions.

A look at the aims of regulation also gets us beyond the dichotomy between big and small institutions. The increased compliance burden being imposed on financial institutions of all shapes and sizes is in some instances a legitimate cost of doing business. For example, today’s cyber system is only as safe as its most vulnerable entry point. Smaller institutions are going to be under more examiner scrutiny and they should be.

Finally, I hate to see credit unions regulated based on size because it threatens the unity of the industry. But if the goal of regulatory reform is to lessen the burden in as prudent a way as possible, then we should be making commonsense distinctions between the largest institutions and everyone else. NCUA would argue that is already taking this approach. It reduced the regulatory burden on credit unions with less than $50 million in assets and recently finalized stress test requirements that only apply to the largest institutions that have a credit union charter. But still more needs to be done by the agency not only in determining what needs to be regulated but in explaining why it needs to impose regulations in the first place.